Exchange-traded funds (ETFs) are the fastest growing investment product in the UK, according to a recent report.
BlackRock’s People & Money report shows a 57% increase in the number of adults invested in an ETF since 2022, with the increase largely driven by younger investors aged 18 to 34.
It has been a record year so far for ETFs, with $1.4tn invested globally, but what are they? Read on to find out how ETFs work and how to get the most out of them.
What is an ETF?
An exchange-traded fund (ETF) is a type of investment fund.
Funds allow you to pool money with other investors to purchase a wider variety of shares. So by buying into an ETF, you’ll be purchasing a stake in multiple stocks.
The main difference between ETFs and other types of funds, such as traditional open-ended funds, is that ETFs are bought and sold on a stock exchange.
As an investor, you buy shares in the ETF instead of directly buying units of the fund. This means you can invest at any time when the stock market is open, whereas funds can only be bought and sold once a day.
ETFs are usually ‘passive’, meaning they invest in line with an index, which is a list of companies such as the FTSE 100. There are, however, an increasing number of active ETFs, where a fund manager chooses specific investments.
There are also other exchange-traded products available such as exchange-traded commodities (ETCs), which are a way of trading commodities such as gold on the stock market.
- Find out more: investment funds explained.
Why have ETFs become so popular?
ETFs have benefitted from a more general trend towards cheaper passive investing.
From the start of 2022 to mid-2024, retail investors withdrew £89bn from active investments and put £37bn into passive investments.
Passive investments, and especially ETFs, are often cheaper than other types of funds in management fees, which are paid as a percentage of the investment.
The average fee for an ETF is 0.51% compared with 1.01% for an average mutual fund, according to Morningstar Direct.
Choosing a cheaper fund is one of very few ways to control how much money you get back from an investment and could potentially save you a significant sum.
- Find out more: are fund fees eating into your returns?
Why ETFs appeal to young investors
BlackRock’s report showed 18 to 34-year-olds are 80% more likely to hold ETFs than over-35s.
The low cost of ETFs has been especially appealing to younger people investing for the first time. ETFs also don’t have the same minimum investment requirements as traditional funds, meaning you don’t need as much money to get started.
On the other hand, older investors who already have traditional funds in their portfolios aren’t so motivated to switch their investments as doing so may incur capital gains tax.
Invesco research found that investors over the age of 55 were less likely to invest in ETFs due to a lack of understanding of how they work.
- Find out more: a beginner’s guide to investing.
Which platform is cheapest for ETFs?
Most platforms charge trading fees for investments that are bought and sold on a stock market, while some charge less to hold these types of investments in an account.
You could save hundreds – or even thousands for investors with large portfolios – by investing in ETFs on a cheaper platform.
The cost of investing in ETFs compared
Note: The account fee and transaction fees for one year, assuming four purchases and four sales, spread across different months. Only compares platforms given a customer score in our most recent reviews. Based on the cheapest plan available.
- Find out more: the best investment platforms in the UK 2024.
ETF risks to watch out for
- Picking the wrong ETF You can find many ETFs tracking the same index, but with slightly different results. This is because not all ETFs have the same accuracy in tracking an index. If you’re shopping around for ETFs to invest in, look at the ‘tracking error’ in a fund’s annual report. This tells you the difference between the fund’s returns and the index it’s tracking.
- Concentrating your investments If you only invest in an ETF focusing on a specific theme, such as healthcare or the US stock market, you’ll be vulnerable to any potential shocks or crashes that are specific to that market. If you spread your investments across sectors and areas, you’ll lessen that impact.
- Short-term thinking When you invest, you should generally be thinking of the long term and not ‘day trading’, which is buying and selling investments on the same day, unless you have expertise and the ability to risk more of your money.
- Securities lending Many ETFs lend shares out to hedge funds or banks to bet on the price of the share going down, for a fee. This can help reduce the cost of the ETF, but also risks driving down the value of the shares in it.